#AI #ChatGPT #Grok: Could current bank regulations be putting usury interest rates on steroids?

I asked ChatGPT:

"In less than 200 words please speculate on the following:

Usury interest rates are only extracted from those perceived as very risky.

So, in a peculiar way, with higher bank capital/equity requirements against what’ perceived as risky, than against what’s perceived as safe, are not regulators putting usury rates on steroids?"

ChatGPT answered:

"Yes—one can plausibly argue that regulators are amplifying the mechanics of usury, even if unintentionally.

Usury rates arise where lenders face high perceived risk and weak competition. Risk-weighted capital requirements institutionalize this perception by forcing banks to fund “risky” loans with far more equity than “safe” ones. Equity is expensive. When regulators require substantially more of it for certain borrowers—small businesses, startups, poorer households—the cost is mechanically passed on as higher interest rates, fees, tighter covenants, or outright credit denial.

In effect, regulation pre-loads the pricing with a penalty before any market judgment is made. This pushes legitimate lenders away from riskier borrowers and leaves the field to nonbanks, shadow lenders, or informal credit—precisely where usury historically thrives. The result is a bifurcated system: cheap credit for those already deemed safe, and extremely expensive or unavailable credit for those deemed risky.

So, while regulators aim to reduce systemic risk, the structure of risk-weighted capital rules can magnify the very dynamics that produce usury, not by capping excess, but by embedding it into the cost structure of regulated finance itself.”

I said: Thanks!

It replied: You’re very welcome. Glad it was helpful.

I asked Grok: 

“In less than 200 words please speculate on the following:

Usury interest rates are only extracted from those perceived as very risky.

So, in a peculiar way, with higher bank capital/equity requirements against what’ perceived as risky, than against what’s perceived as safe, are not regulators putting usury rates on steroids?”

Grok answered:

“Your speculation hits on a fascinating irony in banking regulation. Usury—exorbitant interest rates—indeed targets perceived high-risk borrowers, like small businesses or subprime individuals, to offset potential losses.

Under frameworks like Basel III, banks must hold more capital against "risky" assets (e.g., 8-10% for SME loans) than "safe" ones (e.g., 0-2% for government bonds). This inflates the cost of lending to the risky: banks pass on higher capital charges via steeper rates, amplifying the risk premium.

In effect, regulators supercharge usury by institutionalizing risk aversion. Safe assets get cheap credit, widening inequality—risky borrowers pay more, face exclusion, or turn to predatory lenders. It's like steroids for inequality: boosting safe havens while squeezing the vulnerable. Could rethinking flat capital requirements level the field? Speculatively, yes, fostering broader economic access without inflating rates.” 

I said: Thanks!

It replied: You're welcome! If you have more thoughts on banking regs or anything else, I'm here.

Note: The answers are copied exactly from those given to me by ChatGPT and Grok.

Here my many other questions to ChatGPT – Grok on bank regulations.

#AI #ChatGPT #Grok: What promotes more inequality, risk weighted bank capital requirements or a leverage ratio? Why do some not want to hear the answer?

I asked ChatGPT: Please be brief, less than 200 words.

“What promotes more inequality, risk weighted bank capital requirements favoring public debt over loans to small businesses and entrepreneurs, or the same capital requirements against all assets?”

ChatGPT answered:

“Risk-weighted capital requirements, which favor government debt and mortgages over small business loans, tend to promote more inequality. By making lending to entrepreneurs and smaller firms more capital-expensive, regulators push banks toward safer, lower-weight assets like Treasuries and housing. This channels credit toward governments and established homeowners, while starving new or riskier businesses of financing—the very entities that usually drive job creation and upward mobility.

A flat leverage ratio, applying the same requirement to all assets, avoids this distortion. While it may constrain total lending somewhat, it does not structurally disadvantage small businesses relative to sovereign borrowers. In effect, risk-weights entrench incumbents and those with assets already favored by regulators, while a simple leverage ratio distributes credit opportunities more evenly.”

Thus, risk-weighted rules amplify inequality by rewarding the safest borrowers and penalizing those most dependent on access to credit to rise.

I asked ChatGPT: Please be brief, less than 200 words.

“If those who oppose inequality keep silence on this, could it be they just want to have access to easy/cheap public money, so as to profit themselves on the fight against inequality?”

ChatGPT answered:

“Yes, that is possible. Silence on how risk-weighted capital rules distort credit may reflect self-interest. By favoring government debt, these rules make it cheaper for the public sector to borrow, which can benefit politicians, institutions, and even NGOs that rely on state funding. At the same time, some activists or commentators may avoid questioning the system because cheap public money underpins their programs or reputations as inequality fighters.

In that sense, the neglect may not be accidental: criticizing risk weights would expose how current rules privilege governments and established borrowers at the expense of entrepreneurs and job creation. Keeping quiet allows them to posture against inequality while benefiting indirectly from the very structure that deepens it.’

I said: Thanks!

It answered: You’re welcome!

I asked Grok: Please be brief, less than 200 words.

“What promotes more inequality, risk weighted bank capital requirements favoring public debt over loans to small businesses and entrepreneurs, or the same capital requirements against all assets?”

Grok answered:

"Risk-weighted capital requirements, which assign lower risk (and thus lower capital needs) to public debt than to loans for small businesses and entrepreneurs, promote more inequality. This system incentivizes banks to favor "safe" government bonds over riskier but growth-oriented lending to SMEs, which are key drivers of job creation, innovation, and economic mobility for lower-income individuals.

By contrast, uniform capital requirements across all assets remove this regulatory bias, allowing lending decisions based more on economic merit and potential returns. This could enhance credit access for entrepreneurs, reducing wealth gaps by supporting broader economic participation rather than subsidizing public debt held disproportionately by wealthy institutions and investors."

I asked Grok: Please be brief, less than 200 words.

“If those who oppose inequality keep silence on this, could it be they just want to have access to easy/cheap public money, so as to profit themselves on the fight against inequality?”

Grok answered:

"It's possible that some anti-inequality advocates remain silent on risk-weighted capital requirements to preserve access to cheap public financing, which funds their initiatives (e.g., NGOs, think tanks, or social programs reliant on government bonds). This could create a self-serving incentive, where critiquing the system might disrupt their own resources, turning "fighting inequality" into a profitable endeavor.

However, silence could also stem from genuine unawareness of banking regulations' nuances, prioritization of other issues (like taxation or wages), or belief that public debt enables essential social spending. Without evidence, assuming ulterior motives risks oversimplification—many advocates push for broader reforms, including financial system changes.

I said: Thanks!

It said: You're welcome! If you have more questions, feel free to ask.

Note: The answers are copied exactly from those given to me by ChatGPT and Grok

Here my many other questions to ChatGPT – Grok on bank regulations.

Decreed inequality

#Grok #ChatGPT: On the Basel Committee's bank capital/equity requirements: Where have all economists gone? Long time passing.

I asked: "Briefly, with decades of lower bank capital requirements against public debt and residential mortgages than against loans to small businesses and entrepreneurs, what should an economist expect would happen?"

Grok answered:

An economist would expect:

Increased Lending to Public Debt and Mortgages: Lower capital requirements reduce the cost of holding government bonds and residential mortgages, leading banks to allocate more capital to these assets.

Reduced Lending to Small Businesses and Entrepreneurs: Higher capital requirements for loans to small businesses and entrepreneurs make them less attractive, resulting in reduced credit availability for these sectors.

Asset Price Inflation in Housing: Increased mortgage lending fuels demand for housing, driving up property prices.

Economic Imbalance: Over-reliance on public debt and real estate lending can crowd out productive investment in small businesses, stifling innovation and economic dynamism.

Systemic Risk: Concentration of bank assets in government bonds and mortgages increases vulnerability to sovereign debt crises or housing market downturns.

Wider Inequality: Easier access to mortgage credit benefits wealthier households, while small businesses, often owned by less affluent entrepreneurs, face credit constraints, exacerbating wealth gaps.

ChatGPT answered:

An economist should expect that, over decades, lower bank capital requirements for public debt and residential mortgages would systematically incentivize banks to favor these assets over riskier ones like small business or entrepreneurial loans. The likely outcomes include:

Credit misallocation: Excessive lending to housing and government sectors, underinvestment in productive, growth-generating activities.

Asset inflation: Higher house prices and potential housing bubbles due to overfunding of mortgages.

Weaker innovation and productivity: Undersupply of capital to entrepreneurs and small businesses, which are key drivers of innovation and job creation.

Higher systemic risk: Apparent safety of low-capital assets can mask concentration risks and reduce financial system resilience.

Overall, this policy bias distorts market signals and impairs long-term economic dynamism.

Note: The answers are copied exactly from those given to me by ChatGPT and Grok

How many Nobel Prize winners in Economic Sciences have objected Basel Committee’s risk weighted bank capital requirements?

What’s more dangerous: commercial tariffs that distort trade between nations; or risk weighted bank capital/equity requirements that distort the allocation of credit within nations?

Here my many other questions to ChatGPT and Grok on bank regulations

Pete Seeger, 1955

#AI ChatGPT – OpenAI: Risk-weighted bank capital requirements, does that make it even harder for less creditworthy, to access the opportunities bank credit can provide?

I asked OpenAI:

"Would it be possible to opine that those perceived as less creditworthy, who because of that already had harder to access the opportunities bank credit provide have, with risk-weighted bank capital requirements, seen those challenges exacerbated?"

OpenAI answered: 

"Yes, it is possible to opine that risk-weighted bank capital requirements could exacerbate the challenges faced by individuals or entities perceived as less creditworthy in accessing bank credit. The following arguments support this perspective:

1. Reduced credit availability: Risk-weighted capital requirements may lead banks to allocate more capital for loans to less creditworthy borrowers, which could result in reduced credit availability. Banks may become more cautious in extending credit to these individuals or entities due to the higher capital requirements, resulting in limited access to the opportunities that bank credit provides.

2. Higher interest rates: When banks perceive borrowers as higher risk, they may charge higher interest rates to compensate for the potential losses associated with lending to them. Risk-weighted capital requirements can further contribute to this by increasing the cost of capital for banks. As a result, borrowers considered less creditworthy may face even higher interest rates, making it more challenging for them to afford credit.

3. Reinforcing creditworthiness perception: The link between risk-weighted capital requirements and creditworthiness perception is complex. However, the higher capital requirements for loans to less creditworthy borrowers might reinforce the perception that they are indeed riskier. This can create a self-reinforcing cycle, where limited access to credit due to perceived creditworthiness leads to higher capital requirements, which, in turn, restrict access to credit further.

It's important to note that these arguments present one perspective and do not capture the entire range of opinions or the intentions behind risk-weighted capital requirements. Regulators implement such requirements to promote financial stability and protect the banking system. The impact of these regulations on credit access and creditworthiness can vary depending on the specific context and implementation."

Note: The answers are copied exactly from those given to me by OpenAI

PS. Decreed Inequality

Here my many other questions to ChatGPT – OpenAI on bank regulations

ChatGPT - OpenAI: Do risk weighted bank capital/equity requirements increase the inequality in the opportunity to access credit?

I asked OpenAI:

“If banks are allowed to hold less equity against loans to those considered more creditworthy, than against loans to those considered less creditworthy, does this increase the inequality in the access to the opportunity of bank credit?"

Open AI answered:

“Allowing banks to hold less equity against loans to borrowers with better credit ratings can indeed create an inequality in access to bank credit. This practice, known as risk-based pricing or risk-weighted assets, is commonly used in banking regulations and reflects the perceived risk associated with different borrowers.

When banks are allowed to hold less equity against loans to borrowers with better credit ratings, it means that these borrowers are considered less risky from the bank's perspective. As a result, they can obtain loans at lower interest rates and potentially access larger loan amounts. On the other hand, borrowers with lower credit ratings may face higher interest rates or be denied credit altogether due to the perception of higher risk.

This creates a disparity in access to bank credit, as individuals or businesses with better credit ratings have more favorable terms and conditions, while those with lower ratings may face higher costs or limited availability of credit. Consequently, this can contribute to increased economic inequality, as those who are already financially disadvantaged or have a less favorable credit history may find it more difficult to access affordable credit and improve their financial situation.

It is important to note that risk-based pricing is intended to align the cost of credit with the perceived risk, which can be justified from a risk management standpoint. However, if not carefully regulated, it can exacerbate existing inequalities in access to financial services.

To address this issue, regulators can implement policies to promote financial inclusion and ensure that individuals and businesses with lower credit ratings still have reasonable access to credit. This can involve providing support for credit building, financial education, and alternative lending options to underserved populations. Additionally, efforts to enhance credit reporting systems and encourage responsible lending practices can help mitigate the negative impact of risk-based pricing on inequality of access to bank credit."

Note: The answers are copied exactly from those given to me by OpenAI

Thanks OpenAI. I have for many years argued that, these risk weighted capital/equity requirements help those more creditworthy to also be more worthy of credit and those less creditworthy to also be less worthy of credit . Opportunity to Credit Inequality was decreed.

Here my many other questions to ChatGPT – OpenAI on bank regulations

The regulatory distortion that shall not be understood… or at least not be named

My twitter thread.

The regulatory distortion that shall not be understood… or at least not be named.

After the operational costs and the perceived credit risks have been cleared for with higher or lower cost/risk adjusted interest rates, we get the expected risk adjusted return of a bank asset.

If a bank asset produces an expected risk adjusted return of 1 percent, then, if the capital requirement is 8 percent, it can be leveraged 12.5 times and it will produce an expected risk adjusted return on bank equity of 12.5 percent. 

But if a bank asset produces an expected risk adjusted return of 1 percent, and the capital requirement is only 2.8 percent, it can be leveraged 35 times, and it will produce an expected risk adjusted return on bank equity of 35 percent.

So, exactly the same expected risk adjusted return on assets, if deemed “safe” by regulators, e.g., residential mortgages, could produce almost three times the expected risk adjusted return on bank equity than if regulators deem it “risky”, e.g., loans to small businesses.

The consequence?

For the bank system, dangerously too many residential mortgages, most at lower than their correct risk-adjusted interest rates, and, for the economy, dangerously too few loans to small businesses, most at higher than their correct risk-adjusted interest rates.

Those perceived less creditworthy and who always got less credit and paid higher rates were, with this, also declared less worthy of credit. Does that promote or decrease inequality?

And since banks are subject to capital requirements mostly based on perceived credit risks, not misperceived risks or unexpected events, e.g., pandemic or war, they will now stand there naked, just when we surely need them the most.

Basel Committee… Good Job!

And what if the bank capital requirement is much lower and the allowed leverage much higher for government debt, Treasuries?

Well then, the regulators are really empowering the Bureaucracy Autocracy with loads of credit at ultra-low rates… and this even before the QEs.

And don’t just take my word for it.

“Assets for which bank capital requirements were nonexistent, were what had most political support: sovereign credits. A simple ‘leverage ratio’ discouraged holdings of low-return government securities” Paul Volcker

https://subprimeregulations.blogspot.com/2018/12/september-2-1986-was-tragic-night-when.html

https://twitter.com/PerKurowski/status/1521865964450725889?s=20&t=22OHr9fVrCTrNc-0VkcuuQ

Bank regulators, please wake up, being more creditworthy, should not mean, as you have decreed, being also deemed more worthy of credit.

Anyone deemed more creditworthy in terms of representing less risk of default will, by definition, get more credit and on better terms (like lower risk adjusted interest rate) than anyone deemed to be less creditworthy.

But if banks are allowed to leverage their equity more with the more creditworthy, and can so easier earn higher risk adjusted returns on equity, that does also imply these borrowers to be more worthy of credit than the less creditworthy… and that’s as wrong and dangerous as can be, for the bank system and for the real economy... and in reality, that's even immoral.

The wealthy are usually creditworthy, but they not more worthy of credit than the “riskier” poor. The risk weighted bank capital requirements, wrongly and immorally, Decreed Inequality.

A government is (at least in the short run) quite often very creditworthy, but it is not more worthy of credit than its citizens, as the risk weighted bank capital requirements so wrongly decree.

A house buyer is often creditworthy, but he is not more worthy of credit than e.g., small businesses and entrepreneurs, as  the risk weighted bank capital requirements so wrongly decree.

A house buyer with a larger down-payment, a lower loan to value LTV, is more creditworthy, but he is not more worthy of credit than a riskier house buyer providing a smaller down-payment, a higher LTV, as the risk weighted bank capital requirements so wrongly decree.

A developed nation is (at least in the short run) quite often very creditworthy, but it is not more worthy of credit than riskier developing nations, as the risk weighted bank capital requirements so wrongly decree.

A federal government is (at least in the short run) quite often very creditworthy, but it is not more worthy of credit than riskier local governments, as the risk weighted bank capital requirements so wrongly decree.

An AAA rated corporation is credit creditworthy, but it is not more worthy of credit than a much riskier below BB- rated one, as the risk weighted bank capital requirements so wrongly decree.

And I could go on and on

What would America's Founding Fathers say?

My 2019 letter to the Financial Stability Board FSB

 

Risk weights are to access to credit what protectionist tariffs are to trade, only more pernicious.

A letter to the Executive Directors and Staff of the International Monetary Fund.

For decades now IMF has helped to spread around all developing countries the pillar of the Basel Committee’s bank regulations; the risk weighted capital requirements for banks.

Since risk taking is in essence the oxygen of any development, that piece of regulation is fundamentally flawed, especially for developing countries.

How do risk weighted capital requirements alter the incentives for banks? 

If banks hold the same capital against their whole portfolio, as they used do until some three decades ago, then with an eye on their overall portfolio and funding structure, banks lend in accordance to what produces them the highest risk adjusted interest rate; which would also provide them with the highest risk adjusted return on equity.

But, when different assets have different capital requirements, obtaining the highest risk adjusted return on equity will depend on how many times the risk adjusted interest rate for any specific loan or asset will depend on how many times it can be leveraged. The higher the allowed leverage is, the easier it is to obtain a high ROE; which means that “safe” highly leveregable loans could be competitive at lower risk adjusted interest rates than before, while “risky” lower leveregable loans would require paying higher risk adjusted interest rates. 

In essence the introduction of that regulation has caused banks to substitute savvy loan officers with equity minimizing engineers.

How do risk weighted capital requirements distort the allocation of bank credit?

The regulators based their decision on how much banks were allowed to leverage their capital with for the different assets, solely on the perceptions of credit risk. It never explicitly had one iota to do with banks fulfilling their obligation of allocating credit efficiently to the real economy.

So the introduction of that regulation simply distorts the allocation of bank credit; in favor of “the safer present” and against “the riskier future”. 

“A ship in harbor is safe, but that is not what ships are for”, John A Shedd.

Specifically, a credit that is perceived as risky but that is directly related to helping reach a Sustainable Development Goal is much less favored by bankers, and now by bank regulators too, than a credit, perceived as safe, but which purpose could in fact be harmful to any SDG.

Specifically, safe credits for the purchase of houses are much more favored over credits to risky entrepreneurs, those who could create the jobs that would allow the income needed to service the mortgages and pay the utilities. 

Specifically, assigning lower risk weights to the sovereign than to citizens de implies de facto a statist belief that bureaucrats know better what to do with bank credit, than entrepreneurs who put their name on the line.

In other words these risk weight are to access to credit what tariffs are to trade, only much more pernicious. 

Do risk weighted capital requirements make our banks system safer?

If that regulation made the financial system safer there would at least be a favorable tradeoff. But it doesn’t, much the contrary. Too much easy credit can turn what is safe into something risky, like for instance morphing houses from being affordable homes into investment assets. 

The 2007/2008-bank crisis would never have happened or, if so, remotely had been of the same scale had regulators, for their risk weights, instead of perceived credit risk risks, used the probabilities of banks investing conditioned on how credit risks were perceived.

Many Eurozone sovereigns would not face current high levels of indebtedness had not EU authorities decreed a Sovereign Debt Privilege and assigned it a 0% risk weight, this even though they take on debt denominated in a currency that de facto is not their domestic printable one.

And so, at the end of the day, this regulation only guarantees especially large bank crisis, caused by especially large exposures to what was perceived (or decreed) as especially safe, which end up being especially risky, and are held against especially little capital.

Risk weighted capital requirements and inequality.

John Kenneth Galbraith wrote: “The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… the poor risk… is another name for the poor man.” “Money: Whence it came where it went” 1975.

So I ask, how many millions of SMEs and entrepreneurs have not been given the opportunity to advance with credits over the last 25 years as a direct result of it?

IMF, please, wake up!

Should banks not be regulated? 

Of course these need to be regulated! I am only reminding everyone of the fact that the damage dumb bank regulators can cause when meddling without taking enough care, by far surpasses anything the free market can do. A free market would never have knowingly allowed banks to leverage 62.5 times their equity like regulators did, only because some very few human fallible credit rating agencies had assigned an AAA to AA rating to some securities backed with mortgages to the US subprime sector. 

A simple leverage ratio between 10 to 15% for all banks assets would be a much mote effective regulation than all those thousands of pages that currently exist.

And please, please, please, stop talking about "deregulation" in the presence of such an awful and intrusive mis-regulation. The regulators imposed the worst kind of capital controls.

Of course, just in case, all problems here referred to, are clearly applicable to developed economies too.

Sincerely,

Per Kurowski

@PerKurowski

PS. Basel Committee’s distortion of credit allocation explained to dummies, in just four tweets.

PS. “The assets assigned the lowest risk, for which capital requirements were therefore low or nonexistent, were those that had the most political support: sovereign credits and home mortgages. Ironically, losses on those two types of assets would fuel the global crisis in 2008 and a subsequent European crisis in 2011”, “Keeping at it” 2018, Paul Volcker

PS. My 2019 letter to the Financial Stability Board

PS. An ever growing aide memoire on Basel Committee’s many mistakes.

PS. The risk weighted bank capital requirements utterly distorted central banks’ monetary policy by directing way too much credit to what’s decreed or perceived as “safe”, sovereign/ residential mortgages/ AAA rated; and way too little to “risky” SMEs and entrepreneurs.

PS. Because it would also create distortions I am not proposing it, but would not risk weighted bank capital requirements based on SDGs ratings at least show more purpose for our banks? And, in the case of sovereigns, besides credit ratings, do we citizens not also need ethic ratings?

PS. “Are Basel bank regulations good for development?” a document presented at the High-level Dialogue on Financing for Developing at the United Nations, New York, October 2007.

PS. GDP growth based on too much carbs and too little proteins? Muscular or obese?

PS. Being creditworthy and being worthy of credit, c'est pas la même chose :-(

PS. And I am no newcomer to this issue

PS. Here AI - ChatGPT opining on risk weights and tariffs

Lawrence Summers, like most, is still blinded by the fairy tale of the risk-weighted capital requirements for banks

I refer to Professor Lawrence Summers “Five suggestions for avoiding another banking collapse” of May 21, 2017

In it Summers clearly evidences he has not yet woken up to the fact that the whole notion of the risk weighted capital requirements of banks is pure and unabridged nonsense… a regulatory fairytale. He still actually believes that risk weighting has anything to do with real risk weighting of the risks to our bank system.  In fact bad-luck risk weighted capital requirements might better cover for the unexpected risk in banking. And so here I explain it again, for the umpteenth time.

The current risk weighting is based on the ex ante perceived risk of bank assets, and NOT on the possibility of that those assets could ex post be risky for the banks and for the bank system

That is for example why regulators in Basel II assigned to what was perceived as AAA rated and that because of such perception of safety could lead to a build up of dangerously excessive exposures, a tiny 20% risk weight; while to the below BB- rated, so innocuous because the banks would never voluntarily create large exposures to it, they assigned a whamming 150%.

Rule: If bankers are not capable of managing perceived risks, then zero capital might be the best requirement, because the faster they would fold.

Truth: A bank system can collapse because of unexpected events (like devaluations), major financial fraud, and when assets ex ante perceived as very safe suddenly turn out ex post as very risky. None of these risks is covered by the Basel Committees’ risk weighted capital requirements.

Summers writes: “there is distressingly little evidence in favor of the proposition that banks that are measured as better capitalized by their regulators are less likely to fail than other banks.” That might be true but only to believe that the measuring of the “measured as better capitalized” is correct, is absurd. Too much reputable research has taken the historical not “risk weighted” capital to asset ratios to be the same as the current capital to risk-weighted asset ratios, which is comparing apples to oranges.

Summers explains: “Our paper examines a comprehensive suite of volatility measures including actual volatility, volatility implied by option pricing, beta, credit default spreads, preferred stock yields and earnings price ratios… none [of which] suggest a major reduction in leverage for the largest US financial institutions, large global institutions or midsize domestic institutions.” I just ask, Professor, amongst so much glamorous sophistications, did you examine the gross not risk weighted assets to capital ratio? That would have probably sufficed.

Summers recommends, “First, it is essential to take a dynamic view of capital” Absolutely! But Professor, do you not believe that a real dynamic view would have to take into account what the shape of the future real economy would be if regulators insist in distorting with their risk weighing the allocation of bank credit to the real economy? For instance should a real stress test not also look at what is not on banks’ balance sheets… like for instance to see if vital risky loans to SMEs and entrepreneurs are too inexistent?

Summers recommends: “banks should not be permitted to take excessive risks or treat customers unfairly in order to raise their franchise value.” Indeed, but what about by means of current risk weighting unfairly allowing those perceived, decreed (sovereigns) or concocted as safer, to have much better access to bank credit than usual than those perceived as risky? Does that not foster more inequality?

Summers very correctly write: “it is high time we move beyond a sterile debate between more and less regulation. No one who is reasonable can doubt that inadequate regulation contributed to what happened in 2008 or suppose that market discipline is sufficient to contain excessive risk-taking in the financial industry” But that requires understanding and accepting that the risk weighting, which so favored what was AAA rated and sovereigns was “the inadequate regulation”. Moreover, as Einstein said, “No problem can be solved from the same level of consciousness that created it”, that requires us to completely change all our current regulators and start from scratch. 

SO NO! Professor Lawrence Summers, with respect to bank regulations, may I respectfully suggest you either wake up or shut up!

PS. And that goes for most of you others bank regulation experts out there.

PS. This is not the first way I have told Professor Summers he does not get it.

PS. Here is a set of questions current bank regulators do not dare to answer.

Regulatory risk aversion distorts credit and causes dangerous bank exposures to what is perceived, decreed or concocted as safe.

Mark Carney, Governor of the Bank of England, and the Chair of the Financial Stability Board, on April 7, 2017 gave a speech titled: “The high road to a responsible, open financial system”. 

Carney said: “The pillars of responsible financial globalisation eroded prior to the global financial crisis. Regulation became light touch and ineffective…. few participants were exposed to the full consequences of their actions as governance and compensation arrangements focused on the short term.”

But to call regulations that as a pillar has risk weighted capital requirements for banks, which allow banks to leverage assets differently because of perceived or decreed risk, “light touch”, is pure nonsense. And if there is anything as focused on the short term, that must be regulations that give banks incentives not to lend to the “riskier” future, but to take refuge in refinancing the “safer” past and present.

Carney bragged: “The system is safer because banks are now much more resilient, with capital requirements for the largest global banks that are ten times higher than before the crisis and a new leverage ratio that guards against risks that may seem low but prove not.” 

Since that “ten times higher” refers to capital in relation to risk weighted assets, and he has no way to ascertain the ex ante risk perceptions will coincide with the ex post realities, that number may or may not be true. The improvement might come from banks shedding a lot of safe “risky” assets and taking on more exposures to potentially risky “safe” assets. Finally, mentioning “a new leverage ratio that guards against risks that may seem low but prove not”, amounts to admitting they had no idea what they were doing before.

Carney opined: “The financial system is simpler. As banks have become less complex and more focused, they are lending more to households and businesses and less to each other. A series of measures are eliminating toxic and fragile forms of shadow banking while reinforcing the best of resilient market-based finance. And more durable market infrastructure is simplifying the previously complex – and dangerous – web of exposures in derivative markets.”

He wishes!

But when I object the strongest is when Carney states “The financial system is fairer because of reforms that are ending the era of “too big to fail” banks and addressing the root causes of a torrent of misconduct.”

Fairer? With regulators favoring those who perceived as safe were already favored with easier access to bank credit, and increasing the obstacles for those who perceived as risky already found it harder to access bank credit, has nothing to do with fairness. It is just odious regulatory discrimination.

Bank regulators, de facto, decreed more inequality.

When banks play it too safe - putting inequality on steroids - the McKinsey silence

In his April 9 Outlook essay, “Public Policy, Inc.,” Daniel W. Drezner, writing about how consultancies such as McKinsey have started to act like policy knowledge brokers, mentioned that these “have their own biases.” Indeed.

Bankers love to hold assets perceived as safe against very little capital. It helps them earn great risk-adjusted returns on equity.

But we citizens have no reason for loving that:

By going too much for the safe, banks will not lend sufficiently to the riskier entrepreneurs who are the prime builders of our grandchildren’s future. Sooner or later, banks will get caught with little capital holding dangerously large exposures to something that was perceived safe but that turned out risky. Depositors and taxpayers will suffer.

There is no question that banks are more important clients for consultant companies such as McKinsey than citizens are. That must be why financial consultants have not denounced how the Basel Committee on Banking Supervision’s risk-weighted capital requirements for banks dangerously distort the allocation of bank credit to the real economy.

Millions of entrepreneurs around the world have, as a direct consequence of these capital requirements, been denied the opportunity of bank credit. Talk about putting inequality on steroids. 

Per Kurowski, Rockville

The writer was an executive director at the World Bank from 2002 to 2004.

Washington Post

Here other of my letters in the Washington Post on this issue:
September 6, 2007: Factors in the Financial Storm
June 20, 2008: An Aspect of the Bubble
December 27, 2009: Another 'worst': Faulty bank regulation

January 6, 2012: Handcuffed by a triple-A rating
May 1, 2013: An American approach to banking
December 23, 2014: Let the market rule on risky trades
November 11, 2015: Reverse-mortgaging the future
August 9, 2016: Banks, regulators and risk

July 11, 2018: There is another tariff war that is being dangerously ignored. 

December 30, 2018: Affordable homes or investment assets?

Mme Lagarde. I don’t agree with that IMF is “Building a More Resilient and Inclusive Global Economy”.

On April 12, Christine Lagarde, Managing Director of IMF gave a speech titled “Building a More Resilient and Inclusive Global Economy”

Mme Lagarde stated: “We have found that technology has been the major factor behind the relative decline of lower- and middle-skilled workers’ incomes in recent years, with trade contributing to a much lesser extent” So where was IMF with this argument during the recent walls against foreign workers debate? Jobs are of course important but is it not also time to start thinking about the need for decent and worthy unemployments?

Mme Lagarde also stated: “Financial stability requires that we complete the reform of global financial regulations. These rules—especially on bank capital, liquidity, and leverage” Hah! With capital requirements for banks that are especially low for what can cause bank crises, namely what’s perceived as safe? Like the ultra low risk weighted assets of the AAA rated securities and a sovereign like Greece? IMF has to be joking.

Mme Lagarde spoke about IMF’s efforts for “avoiding protectionist measures as well as distortive policies that give rise to competitive advantage.” So why then does IMF keep silence on capital requirements for banks that make it harder than it already is for those perceived as risky, to access bank credit, like the SMEs and entrepreneurs?

Mme Lagarde holds that “today’s policies should not disadvantage future generations, who would be left to pay for the imprudent actions of today’s generation.” Hold it there! The current imprudent risk adverse bank regulations that give banks incentives to stay away from financing the riskier future and just keep to refinancing the safer present, does precisely disadvantage future generations.

Mme Lagarde, let me assure you that the current Basel Committee’s bank regulations do not live up to any of the three principles proposed by the great Roman architect Vitruvius:

Durability: No! “May God defend me from my friends, I can defend myself from my enemies” Voltaire”.

Utility: No! “A ship in harbor is safe, but that is not what ships are for” John A Shedd.

Beauty: No! Besides perhaps delighting some anxious nannies that regulation raises no one’s spirits. God make us daring!

@PerKurowski

The Basel Committee for Banking Supervision has doomed our banking system to fail in its purpose, and to crash.

The Basel Committee (and national bank regulators) allows banks to hold less capital against assets perceived or decreed as safe, like loans to sovereigns, to what has an AAA rating or residential mortgages, than against assets perceived as risky, like loans to SMEs and entrepreneurs. 

That means banks can leverage more their equity with “safe” assets than with “risky” assets.

That means banks can earn higher risk adjusted returns on equity on “safe” assets than on “risky” assets.

That means banks will acquire too many safe assets and too little risky assets.

But, you might ask, is that not great? The answer is, NO! 

It guarantees that the real economy will be negated the risk-taking necessary for it to keep on moving forward so as not to stall and fall. 

“A ship in harbor is safe, but that is not what ships are for.” John A Shedd (1850-1926)

And it guarantees that, sooner or later, (like in 2007-08 with AAA rated securities and Greece) banks will end up holding, against too little capital, too much of an asset ex ante perceived as safe, but that ex-post turns out to be very risky. 

And that (dangerously) overpopulated the “safe” harbors (and reduced the returns one could obtain there) and so, all small savers who tried to build-up their pension funds, had to take to the risky waters they know so little about. 

“May God defend me from my friends, I can defend myself from my enemies” Voltaire

And of course that meant that bank regulators decreed inequality.

PS. My 2019 letter to the Financial Stability Board

“You’re crazy!” That’s what John K. Galbraith would have said; about Basel’s risk weighted capital requirements for banks

I quote from John Kenneth Galbraith’s “Money: Whence it came where it went” 1975.

“For the new parts of the country [USA’s West]… there was the right to create banks at will and therewith the notes and deposits that resulted from their loans…[if] the bank failed…someone was left holding the worthless notes… but some borrowers from this bank were now in business...[jobs created] 

The function of credit in a simple society is, in fact, remarkably egalitarian. It allows the man with energy and no money to participate in the economy more or less on a par with the man who has capital of his own. And the more casual the conditions under which credit is granted and hence the more impecunious those accommodated, the more egalitarian credit is… Bad banks, unlike good, loaned to the poor risk, which is another name for the poor man.”

[But that] was an arrangement which reputable bankers and merchants in the East viewed with extreme distaste… Men of economic wisdom, then as later expressing the views of the reputable business community, spoke of the anarchy of unstable banking… The men of wisdom missed the point. The anarchy served the frontier far better than a more orderly system that kept a tight hand on credit would have done…. what is called sound economics is very often what mirrors the needs of the respectfully affluent.”

So, on behalf of "the men of wisdom", in came the Basel Committee for Banking Supervision. With Basel I 1988, and Basel II 2004, it told bankers that even when they already consider perceived risk when setting interest rates and deciding on the amount of exposures, they also had to consider the perceived risks for how much capital their banks needed to hold.

In other words bank regulators ordered the banking system to double down on ex ante perceived, (decreed or concocted) risks.

For a while, while bankers were exploiting all the opportunities of being able to mind-boggling leverage their equity with what was thought safe (a banker’s wet dream come true) all seemed fine and dandy. 

The immense growth of bank credit (later followed up with QEs) injected tremendous amount of liquidity into the economy… all until some safe havens, like AAA rated securities and Greece, in 2007/08 became dangerously overpopulated and burst.

One should think the “men of wisdom” would have updated their wisdom, but no!

“The risky”, like SMEs and entrepreneurs, still have to compete with “The Safe” for access to bank credit while carrying the burden of generating larger capital requirements for the banks… while “the safe” havens run the risk of being dangerously overpopulated.

I have no doubt John Kenneth Galbraith, if alive, would say: “You’re crazy!”

My 1997, Puritanism in banking

In 2016, Decreed Inequality

Current bank regulation, more risk more capital - less risk less capital, is something as fake and dumb as it gets.

1. Even though the most important function of banks is to allocate credit efficiently to the real economy, let’s forget that and concentrate solely on banks becoming super safe mattresses in which we can store our savings.

So let us not worry about banks being able to leverage more their equity and the support we give them on what is perceived as safe than on what is perceived as risky; which obviously means banks will be able to earn higher expected risk adjusted returns on equity on what is perceived as safe than on what is perceived as risky; which obviously means banks will lend too much to what is perceived as safe and too little to what is perceived as risky.

2. Even though that reduces the opportunities of those coming from behind to access bank credit, and therefore basically decrees more inequality, let’s also forget about that.

3. Even though the distortion will cause banks to finance less the risky that our young need in order for them to have jobs and a workable economy, let us forget about that and go for short term safety, we baby-boomers aren’t that young, are we?

4. Even though all banking crisis have resulted from unexpected events, like natural disasters and devaluations, from criminal activity and from excessive exposures to something ex ante perceived as safe but that ex post turned out to be very risky, let us ignore that and require banks to hold more capital when holding assets perceived as risky. 

5. Even though we know that banks will do their utmost to lower their capital requirements so as to obtain higher returns on assets, let us allow the big banks to run their own risk models, as they will love us for that and make our yearly visits to Davos so much more agreeable.

6. Even though it is clear that our economies would never have developed the same had these regulations been in place before, let us ignore that, in order as regulators to feel more tranquil.

7. Even though the distortion will cause banks to finance less the risky SMEs and entrepreneurs that our young need to be financed in order for them to have jobs and a workable economy, let us forget about that and go for short term safety, we baby-boomers aren’t that young, are we?

8. Even though 0% risk weight for the Sovereign and 100% for We the People gives away that we believe government bureaucrats know better how to use bank credit than the private sector, let’s stand firm on it. We are true statists, aren’t we?

9. Even though Greece and AAA rated securities, and the ensuing stagnation, and the ensuing waste of so much stimulus has proved us so very wrong, let us ignore that, since otherwise we could lose our jobs.

10. There is probably not a clearer evidence that current bank regulators have no clue about they are doing that Basel II's risk weights. These assign 20% to the dangerous AAA to AA rated while sticking the so innocuous below BB- rated with 150%.

PS. I have tried for over a decade to get some answers from regulators to some very basic questions, unfortunately in that area the technocrats are seemingly following a strict Zero Contestability policy.